Plosser’s Limited Fed: A Statesman Takes a Stand

by Doug Noland

November 22, 2013

The stock market melt up continues. Meanwhile, intrigue only grows at the Fed. November 19, 2013: “From NPR News, this is All Things Considered. I’m Robert Siegel. And I’m Melissa Block. Americans are utterly fed up with Washington. That’s the takeaway from the latest round of public opinion polls. Approval ratings for just about every leader and political institution from the president to Congress are now at record lows. NPR’s national political correspondent Mara Liasson reports on why and what the consequences might be. Bill McInturff, the Republican half of The Wall Street Journal/NBC polling team calls it a public opinion shockwave. He’s never seen voters express such disgust at both parties and their leaders. Bill McInturff: ‘October was one of the most consequential months in the last 30 years in American public opinion. And the consequences are all negative. The President’s job approvals hit a new low. His personal approvals turned negative for the first time. Republicans became the first political party with a 50% negative and every person in the Congressional leadership hit new highs in their negatives. No one was spared. America’s fed up and very tired of what happens in Washington.’”

These days I think often of Adam Fergusson’s classicWhen Money Dies: The Nightmare of Deficit Spending, Devaluation, and Hyperinflation in Weimar Germany.” One of the more fascinating and pertinent aspects of Fergusson’s historical account was how monetary policymakers somehow remained oblivious to the havoc they were instrumental in fomenting. Throughout the ordeal, top central bank officials believed monetary policy was responding to outside developments instead of being a root cause of deleterious processes that ended up tearing society apart. Despite what should have been an obvious disaster in the making, the central bank succumbed to constant pressure from various constituencies to step up its money printing operation.

Americans’ confidence in its politicians is at a multi-decade low. The popular refrain remains “Thank God for the Federal Reserve!” Somehow, it goes unappreciated that flawed monetary doctrine has been instrumental in fomenting societal stress, divisiveness and the steady erosion in the public’s faith in its institutions. A multi-decade period of unsoundmoney” and Credit has fueled an ongoing perilous cycle of asset Bubbles, booms and busts, gross misallocation of resources with resulting economic stagnation, and inequitable wealth distribution on a historic scale. Unfettered money” and Credit on an unprecedented worldwide basis have been responsible for unmatched global financial and economic imbalances, including the deindustrialization and ever-growing debt overhang that hamstrings the U.S. economy. While it is difficult to hold much sympathy for today’s politicians, I’d argue strongly that years of unsound finance is at the root of today’s increasingly dysfunctional political landscape.

Fundamental to my “Granddaddy of all Bubblesthesis are the momentous risks associated with governments’ and central banks’ reflationary policymaking – a policy course that for five years now has inflated the expansiveglobal government finance Bubble.” QE (“money”-printing) cost vs. benefit analysis has turned more topical of late. Again this week, top Fed officials (Evans and Rosengren) argued that QE benefits greatly exceed marginalpotential costs. History will not be kind. At the end of the day, the loss of confidence in the Fed and central banking more generally will come at a very steep price.

In the spirit of “When Money Dies,” it is unwise for Fed officials to be so dismissive of the costs associated with its experiment in inflationary monetary policy. After all, monetary inflations unleash processes that are unpredictable both in course and eventual outcome. I adhere to the view that asset inflation is potentially more dangerous than traditional consumer price inflation.

Can the Fed actually wind down QE? Or is the Fed’s (prisoner to dysfunctional markets) balance sheet on its way to $10 TN? What would be the consequences? Fed officials have no idea at this point how any of this will play out. Indeed, I’ve seen no indication that they have much understanding of the impact of QE to this pointeven with the benefit of hindsight. Officials seem to suggest that expanding the Fed’s balance sheet to almost $4 TN has had only modest impact other than to somewhat force long-term interest rates lower. At least publicly, they’re sticking with the story that so long as their QE moneysits idly on the banking system’s balance sheet as “reserves” it’s having minimal inflationary effect. It’s just not credible that, with the Fed pumpingmoneydirectly into the securities markets, the focus of cost analysis would remain on consumer prices rather than the myriad distortions and maladjustment associated with asset inflation and speculative Bubbles.

As master of the obvious, I would argue that QE has had profound, albeit disparate, impacts primarily on the financial markets. Moreover, the key is to appreciate that the effects of liquidity injections into the marketplace significantly depend on the prevailing market dynamics at the time. In this regard, there are important differences between “QE1,” “QE2” and the ongoingQE3.”

QE1saw the Fed’s balance sheet expand from about $900bn in September 2008 to end ‘08 at almost $2.3 TN. De-risking and de-leveraging were the prevailing market dynamics at that time. Importantly, it was not a case of the Fed unleashing $1.4 TN of liquidity upon the real economy or even the financial markets. Basically, “QE1accommodated a transfer of bond/MBS holdings from leveraged players (Wall Street firms, banks, hedge funds, mortgage REITs…) to the Fed’s balance sheet. From a cost/benefit perspective, one can argue that the “QE1” was instrumental in stemming a potential daisy-chain collapse of major financial institutions along with the global derivativesmarketplace more generally.

QE1benefits were readily apparent, while most would argue the costs were minimal. I would counter that myriad associated costs were enormous if not evident. “QE1” was instrumental to the ongoing general expansion in global Credit and speculative excess, including the further ballooning of the “global leveraged speculating community” and global market and derivatives Bubbles more generally. “QE1stopped in its tracks what would have been a painful but healthy cleansing of an “inflationary bias” and financial market speculation infrastructure that have been flourishing for the past twenty years. “QE1” also reversed what would have been a major restructuring of our services/consumption-based economy – and we would have been in a better place today because of it.

I’ll concede that the original QE was likely necessary to forego major financial and economic restructuring. Yet it was then critical for a diligent Fed to be on guard against speculative excess - rather than actively spurring speculation and asset inflation.

QE2saw the Fed’s balance sheet expand from $2.3 TN in October 2010 to $2.9 TN by June 2011, with market impacts pushed well into 2012 by an additional $400bn of long-term Treasury purchases associated with “Operation Twist” (Fed sells T-bills and buy bonds). To be sure, “QE2pushed already potentinflationary biases” to dangerous extremes. After trading as high as 3.6% in early 2011, 10-year Treasury yields sank to 1.45% in May of 2012. Benchmark MBS yields dropped from 4.40% to as low as 1.82%. Government, mortgage, corporate and municipal bond yields collapsed (prices spiked higher) as hundreds of billions flooded into myriad fixed-income funds and instruments.

It's certainly worth noting that “QE2” was instrumental in the surge of destabilizing late-cyclehot moneyflows into emerging market (EM) economies. International Reserve assets (indicative of EM inflows) jumped from about $8.6 TN in October 2010 to almost $10.5 TN by June 2012. It remains too early to gauge the true cost of “QE2in terms of fixed-income excesses and EM financial and economic Bubble distortions. But the impacts were enormous and clearly of an altogether different nature than “QE1.”

The Fed began talking open-ended QE late in the summer of 2012. They claim it was in response to a stubbornly high US jobless rate. I still believe it was more related to acute global financial fragilities. The Fed’s balance sheet began 2013 at about $2.9 TN. Today it’s almost a Trillion higher, in by far history’s largest ever direct injection of central bank liquidity into the financial markets. As always, it’s fascinating to follow how speculative dynamics play out in the markets. With cracks surfacing in both bond and EM Bubbles, the prevailing 2013inflationary biasshifted overwhelmingly (perhaps fatefully) to equities.

As an illustration, follow the trail of outflows from a somewhat less popularTotal Return Bond Fund” (TRBF). To fund outflows, TRBF sells Treasuries to the Federal Reserve. TRBF then transfers Fed liquidity to exiting investors that then use this money” for investment in the now extremely popularTotal Stock Market Index Fund”. This fund then takes thismoney” that originated with the Fed and bids up stock prices.

Or, how about an example where a hedge fund moves to exit an underperforming emerging bond market. Here the fund is unwinding a leveragedcarry trade” that involves selling the EM bond and liquidating the EM currency position. With the EM bonds and currency under intense (“hot money outflow) pressure, the local EM central bank intervenes with currency purchases (sells dollars to buy the local currency). To fund these purchases, the EM central bank sells Treasuries to the Federal Reserve. The central bank then uses Fed liquidity for purchasing currency from the hedge fund, and the hedge fund then has “money” to rotate into 2013’s speculative vehicle of choice - US equities.

Any serious discussion of QE costs would now have to also consider the risks associated with a full-blown equities market Bubble. And, from my perspective, the Fed’s QE-induced equities Bubble joins a historic fixed-income Bubble to achieve virtually systemic distortion in the pricing and risk perceptions of financial assets generally. If Fed officials actually attempted a cost benefit analysis prior to commencingQE3”, I seriously doubt they contemplated a 40% surge in the broader U.S. stock market.

It seems an increasing number of Fed officials recognize the need to rein in the growth of the Fed’s balance sheet. As Federal Reserve Bank of Atlanta president Dennis Lockhart (under)stated Friday: “There is a fair amount of uncertainty related to the longer-term consequences of growing the balance sheet. There could be some things that happen that are unanticipated.” You think?

I would also like to draw attention to a paper presented last week (Cato Institute’s 31st Annual Monetary Conference) by Federal Reserve Bank of Philadelphia President Charles Plosser, “A Limited Central Bank.” Mr. Plosser’s exceptional analysis is music to my analytical ears and has provided a glimmer of hope that some learned Statesmen will rise up and ensure this monetary inflation doesn’t spiral completely out of control. I can only hope his paper becomes a rallying cry throughout the Federal Reserve system.

From the “highlights”: “President Charles Plosser discusses what he believes is the Federal Reserve’s essential role and proposes how this institution might be improved to better fulfill that role. President Plosser proposes four limits on the central bank that would limit discretion and improve outcomes and accountability. First, limit the Fed’s monetary policy goals to a narrow mandate in which price stability is the sole, or at least the primary, objective; Second, limit the types of assets that the Fed can hold on its balance sheet to Treasury securities; Third, limit the Fed’s discretion in monetary policymaking by requiring a systematic, rule-like approach; And fourth, limit the boundaries of its lender-of-last-resort credit extension. These steps would yield a more limited central bank. In doing so, they would help preserve the central bank’s independence, thereby improving the effectiveness of monetary policy, and they would make it easier for the public to hold the Fed accountable for its policy decisions.”


Turkey pushes crossroads politics

By Pepe Escobar

Nov 22, '13

 While everyone is concentrated on the possibility of a tectonic shift in US-Iran relations, and while a solution may be found for the Syrian tragedy in another upcoming set of negotiations in Geneva, Turkey is silently toiling in the background. Let's see what these sultans of swing are up to.
We start on the internal front. Abdul Mejid I, the 31st Ottoman sultan (in power from 1839 to 1861) always dreamed of a submerged tunnel under the Bosphorus linking Europe to Asia.

It took "Sultan" Erdogan, as in Prime Minister Recep Tayyip Erdogan, to make it happen, when last month he inaugurated - on

the 90th anniversary of the founding of Ataturk's Republic - the US$3 billion, 76-kilometer Marmaray rail system which, in the hardly hyperbolic words of Mustafa Kara, mayor of Istanbul's Uskudar district (where the tunnel comes out), will "eventually link London to Beijing, creating unimagined global connections". [1]
It certainly helps that this technological marvel fits right into China's extremely ambitious New Silk Road(s) strategy which, just like the original Silk Road, starts in Xian, and aims to cross to Europe via, where else, Istanbul. [2]

So the fact remains that "Sultan" Erdogan simply has not been downed by the Gezi Park protests last June. All the ruling party AKP's mega-projects - supported by millions in rural Anatolia, ignored for decades by the secular elites in Istanbul - are alive and kicking.

By 2025, more than a million commuters will be using the Marmaray. The third Bosphorus bridge, close to the Black Sea, is being built - despite Alevi fury that it will be named after Selim The Grim, a sultan who ordered the slaughter of thousands of Alevis.

Same for the new six-runway airport northwest of Istanbul. And then there's the 50 km "crazy canal" (Erdogan's own definition), linking the Sea of Marmara to the Black Sea, so monstrous tanker traffic may be diverted away from the Bosphorus. The Turkish green movement insists this could destroy whole aquatic ecosystems, but Erdogan is unfazed.

That oily Kurdish factor

In the wider world, Turkish foreign policy is now on overdrive. And inevitably, it's all related to energy.
Foreign Minister Ahmet Davutoglu earlier this month hosted Iranian Foreign Minister Javad Zarif in Ankara. Then he went to Baghdad and met Iraqi Prime Minister Nouri al-Maliki.

Davutoglu also visited Washington; he wrote an editorial published by Foreign Policy praising the US-Turkish "strategic partnership", now facing "an increasingly chaotic geopolitical environment"; and he made sure to support US-Iran negotiations.

Earlier this week, Davutoglu teamed up with Erdogan for a high-level meeting with Russian President Vladimir Putin and Foreign Minister Sergei Lavrov in St Petersburg. Next week he'll be in Tehran

The question is what does Ankara want from Washington for so eagerly supporting a US-Iran normalization?

The key is Iraqi Kurdistán. Ankara wants Washington's blessing for the now famously fractious 250,000 barrel-a-day oil pipeline from northern Iraq, bypassing Baghdad. This pipeline would add to the perennially troubled Kirkuk-Ceyhan, controlled (sort of) by Baghdad; currently operating at best at one-fifth of its official capacity of 1.6 million barrels a day, bombed virtually every week, and with zero maintenance.

It's not as much about the oil (which Turkey badly needs) as a political/economic alliance that ideally translates into more Kurdish votes for the ruling AKP party in the 2014 Turkish elections.

The (insurmountable) problem is the Obama administration has no intention - at the present negotiation junction - to provoke Tehran by allowing a Turkish project that most of all provokes Iran's ally Baghdad. That's just another instance that everything of consequence happening in Southwest Asia nowadays involves Iran. [3] 

So it all depends on how far the US-Iran rapprochement will go - leaving Ankara unable to alienate Baghdad and Tehran at the same time. Ankara, though, is also aware of huge potential benefits down the line. That would mean much more oil and gas flowing from Iran than the current long-term annual contract for natural gas via the Tabriz-Ankara pipeline if - and when - Western investment start pumping again into Iran's energy industry.


That Wahhabi-Likudnik axis

 President Obama gets along very well with Turkish Prime Minister Erdogan. But while Obama has nothing but praise for Erdogan, for the House of Saud the name "Obama" is now worse than any plague. And Erdogan is not exactly that much popular.
Erdogan enthusiastically supported Morsi and the Muslim Brotherhood in Egypt, while the House of Saud's hero is coup plotter General Sisi. In Syria, Erdogan once again supports the Muslim Brotherhood-linked "rebels", while the Saudis, with Bandar Bush ahead of the pack, de facto finance and weaponize all sorts of nasties including the al-Qaeda offshoot Islamic State of Iraq and the Levant (ISIL). Erdogan has evolved an extremely fractious relationship with Israel, while the Wahhabi-Likudnik anti-Iran/Syria axis has never been stronger. [4]

It's easy to forget an Ankara-Damascus-Tehran alliance was in place before the foreign-imposed Syrian civil war. That was part of Davutoglu's "zero problems with our neighbors" doctrine, then morphed into "all kinds of problems". The House of Saud obviously did what it could to undermine the former alliance with the carrot of more trade and investment in Turkey. It worked for a while, when the myth of an "Arab Spring" still held sway, and Turkey and the Saudis were even coordinating their support for assorted Syrian "rebels".

Now it's a totally different configuration. Only in Turkey we find assorted Islamists, secularists, the left and assorted liberals all in agreement that the House of Saud is a pretty nasty bunch. And not by accident "Sultan Erdogan" - who allegedly wants the return of the Caliphate - has been derided non-stop all over pan-Arab media, which for all practical purposes is 90%-controlled by Saudis

Ankara seems to have finally realized it must be very careful regarding its Syria position. Not very far from its borders, Syrian Kurds are fighting Saudi-supported jihadis.

Worse; scores of al-Qaeda-linked jihadis-to-be - a Mujahideen International - are congregating in a network of safe houses in southern Turkey, including Antakya, the capital of Hatay province, before being smuggled over the border to mostly join the Islamic State of Iraq and the Levant (ISIL). Predictably, NATO is not amused. [5]


It's all about Pipelineistan

 Turkey's number one foreign policy aim is to position itself as a critical energy crossroads for any oil and natural gas coming from Russia, the Caspian, Central Asia and even the Middle East to Europe.
Yet Turkey has been squeezed by two conflicting Pipelineistan narratives. One is the never-ending soap opera Nabucco, which basically means delivering natural gas to Europe from just about anywhere (Azerbaijan, Turkmenistan, Iran, Iraq, even Egypt) except Russia. And the other is the South Stream pipeline, proposed by Russia and crossing the Black Sea.


in its role as a neutral bridge between East and West, Ankara hedged its bets. But after the European financial crisis took over, Nabucco was, for all practical purposes, doomed. What's left now is the so-called Nabucco West - a shorter, 1,300 km pipeline from Turkey to Central Europe - and the much cheaper Trans-Adriatic Pipeline (TAP), just 500 km from Turkey across the Balkans to Italy.

The consortium (including BP, Total and Azerbaijan's SOCAR) developing the huge Shah Deniz II field in Azerbaijan ended up choosing TAP. So Nabucco is now virtually six feet under.

To say that's been a nifty deal for Moscow is a huge understatement. TAP does not threaten Gazprom's hold on the European market. And besides, Moscow got closer to Baku. Dick Cheney must adjust his pacemaker for another heart attack; after all his elaborate energy plans, Moscow and Baku are nothing less tan discussing transporting Russian oil through the notorious Baku-Tbilisi-Ceyhan (BTC) pipeline, which Dr Zbig Brzezinski dreamed up to exactly bypass Russia. On top of it, they are also bound to reverse the Baku-Novorossiysk pipeline to pump Russian oil into Azerbaijan.

Additionally, that's the end of Turkish (and European) pipe dreams of having wacky "gas republic" Turkmenistan supplying energy across the Caspian through the Caucasus and Turkey to Europe. For Moscow, this is non-negotiable; we control the transit of Central Asian energy to Europe. Moreover, Turkmenistan already has better sturgeon to fry - via its ultra-profitable gas pipeline to China.

The bottom line: Russia getting even more ascendant in the Caucasus equals Turkey - which imports nearly all of its oil, coal and natural gas - becoming even more energy dependent on Russia. Russia supplies nearly 60% of Turkey's natural gas - and rising. Iran supplies 20%. Moscow is sure Turkey will soon overtake Germany as its biggest energy client

That's certainly what Erdogan was discussing in detail this past Wednesday in Moscow. And then there is Turkey's ambitious plan to build 23 nuclear power plants by 2023. Guess who's ahead? Moscow, of course. Not only as builder but also as primary supplier of nuclear fuel. No package of Western sanctions seems to be on the horizon.

So Ankara seems to be (silently) hectic on all fronts. Erdogan is carefully cultivating his friend Obama - positioning himself as a privileged sort of messenger. Erdogan supports Iran's civilian nuclear program - which instantaneously placed him as highly suspicious in the eyes of the Wahhabi-Likudnik axis of fear and loathing. That's the key reason for the widening estrangement between Ankara and Riyadh

Ankara's desire to be a key actor in an eventual US-Iran rapprochement springs out of a simple calculation. Faced with tremendous political, economic and security barriers, Turkey may only fulfill its wish of becoming the privileged East-West energy transit corridor with Iran by its side.


 1. Asia and Europe to get Bosphorus rail link as Marmaray opens, Hurriyet Daily News, October 28, 2013.
New Silk Road starts with Xian, South China Morning Post, October 29, 2013.
Deal or No Deal, Iran's Stock Keeps Rising, Al-Akhbar English, November 20, 2013.
The Wahhabi-Likudnik war of terror, Asia Times Online, November 20, 2013.
The secret jihadi smuggling route through Turkey, CNN, November 5, 2013.

Pepe Escobar is the author of
Globalistan: How the Globalized World is Dissolving into Liquid War (Nimble Books, 2007), Red Zone Blues: a snapshot of Baghdad during the surge (Nimble Books, 2007), and Obama does Globalistan

(Nimble Books, 2009). 

Mario Draghi: ECB needs "safety margin" against deflation

European Central Bank President defends cutting rates to near-zero levels amid criticism from Germany

By Ambrose Evans-Pritchard

6:10PM GMT 21 Nov 2013

The European Central Bank's new chief Mario Draghi gestures during his first press conference at the ECB in Frankfurt
Mario Dragh said the eurozone’s inflation rate has been in “slow motion” decline for several months Photo: AFP
The European Central Bank has fought back against harsh German criticism, insisting that it had to cut rates to near zero to head off deflation risks and stabilize debt burdens in the crisis states.
Mario Draghi, the ECB’s president, said the eurozone’s inflation rate has been in “slow motiondecline for several months. This has spread to all major components of the price index since the summer, pushing the inflation rate down to 0.7pc. Prices have actually fallen over the last three months.
Mr Draghi told an audience in Berlin that the bank acted to secure a “safety margin against deflationary risks”, acknowledging that last week’s rate cut to 0.25pc had set off a political storm and raised fears over an erosion of savings.
Both German members of the ECB’s council opposed the cut. The German media has described it as a Latin coup to seize control of the ECB’s policy machinery. Hans Werner Sinn, head of Munich's IFO institute, accused Mr Draghi of misusing the ECB to bail out Italian debtors.
The experience of Japan in the 1990s is that once the authorities let inflation fall too low, the country became vulnerable to any deflationary shock from the outside. This happened with the East Asia crisis of 1997 to 1998, pushing Japan over the edge into a deflation trap.

Mr Draghi’s plea came as the eurozone’s PMI surveys for November came in weaker than expected, with the added twist that Germany is vastly outperforming France. “It is extremely disappointing and worrying. Recovery will remain tortuously slow,” said Howard Archer from IHS Global Insight.
France’s manufacturing index fell to a six-month low of 47.2pc. The private economy as a whole has slipped back into contraction. Dominique Barbet from BNP Paribas said the data showed France was “well into the theoretical recession territoryafter GDP declined in the third quarter.

Any such relapse would be a serious blow to president François Hollande, who trumpeted earlier this year that the crisis was over. Mr Hollande’s approval ratings have dropped to 20pc, the lowest of any French leader in modern times.

Jean-Michel Six from Standard & Poor’s said France is lagging the whole eurozone and is rapidly losing export share to Spain, where costs have been slashed.
“The Spanish are producing same kind of goods in automotive components and other sectors as the French, but they are much more competitive. You can’t blame France’s problems on the strong euro. Spain uses the same euro,” he said.

Mr Draghi said low inflation in the eurozone is complicating efforts by Club Med crisis states to carry out internal devaluations within EMU to regain competitiveness, while at the same time controlling their debt trajectories.
“If average inflation is allowed to drift too low at the euro area level, it is much harder for those countries to undershoot the average. Adjustment runs into major head winds as demand suffers and real debt burdens rise,” he said.

The comments follow warnings this week by the OECD watchdog that the eurozone’s crisis policy cannot work unless there is more stimulus in Germany and the eurozone core to balance the adjustment.

It said the attempt to drive down wage costs across Southern Europe through deflation is leading to a debt trap, and is in contradiction with the other objective of controlling debt ratios.

This critique has been made by leading economists off all stripes from the across the world.
In a clear riposte to critics in Germany, Mr Draghi said the ECB’s 2pc inflation target is “defined for the euro area as a whole”. This necessarily means that some countries may go through bouts of inflation above 2pc to balance the system, when they are growing faster than others.
He reminded the audience that the framework was devised by Otmar Issing, the former high priest of the Bundesbank and the venerated chief economist of the ECB in its early years.

Mr Draghi said Portugal, Ireland, and Greece have slashed relative labour costs by 15pc since 2009, and have achieved current account surpluses. They are no longerliving beyond their means”.
Yet he admitted that the wrenching adjustments have cut the eurozone’s economic output and perhaps also its growth rate. Euro area countries are using the second decade of the euro to undo the mistakes of the first,” he said.